By Francisco Toro of CaracasChronicles

With the largest oil reserves in the Western Hemisphere, Venezuela might appear like a natural candidate to attract major Direct Foreign Investment funds. But, as a direct result of Mr. Chávez’s policy of marginalizing private sector capital, Foreign Direct Investment flows actually slammed into reverse in 2009 – the latest for which ECLAC figures are available. United Nations 2009 Report ECLAC). Venezuela continues to experience a net outflow of foreign direct investment to the tune of $3.1 billion a year (page 53 of the report). Investors thinking of doing business in Venezuela should be aware that they are likely to lose money in the process.

Such startling figures are driven largely by the Chávez government’s nationalization drive, since compensation for expropriated businesses is counted as “negative” Foreign Direct Investment. What does this tell us? Rather than seek out new foreign investors, the Venezuelan government is busily buying out those who stopped by in the past.

The dearth of foreign investment not only slows economic growth now, it will also undermine the medium-to-long-term competitiveness of the Venezuelan economy. New businesses tend to “flock together” for a reason: each new foreign investor needs the plant equipment, technology and business services – from data-banks to accounting – other foreign companies offer. With investments flowing out of Venezuela at a record pace, new foreign investors find themselves between a rock and a hard place in Chávezland. In addition, with next to none or few new investments coming into Venezuela outside the extractive sector, domestic firms aren’t enjoying any of the positive spillover effects from foreign investments – whether it is the most advanced technology, added dynamism, or cutting-edge management practices.

Seek advice on becoming a foreign investor in Venezuela these days and your enquiries are likely to be met with blank stares. The disincentives now facing potential foreign investors is formidable. Venezuela has one of the world’s most hostile environments for business as well as the tightest foreign exchange control regimes. Its labor market is exceptionally rigid.  Last but not least, Venezuela’s notoriously byzantine red-tape that characterizes any routine business operations is bewildering enough to confirm that it is intentional.

Remarkably, Venezuela has never officially rescinded the “National Treatment” provisions adopted during its short-lived economic reform experiment during the early 1990s. The provisions stipulate that foreign investors are not to be discriminated against vis-à-vis domestic investors. One can argue that it is a principle that the government has largely respected, but only in the sense that domestic investors face much of the same hardships as their international counterparts. It is, arguably, not foreign investment the government is concerned with short-circuiting, but rather private investment in general, regardless of its source.

The one type of investment that is still flowing into the country in any significant quantity is investment in oil projects in Venezuela’s rich – but expensive to exploit – Orinoco Tar Belt. There, state-owned oil companies from ally countries often receive – though not always – most favored treatment. China has signed a $20 billion financing facility – tied to a major investment by Sinopec Corp. – in the region. Likewise, Russia’s Lukoil and Gazprom as well as Iran’s Petropars gas contractor have received lucrative development contracts there, as has PetroVietnam.

To the extent that major Western companies are able to find investment opportunities in Venezuela, it’s almost always in the oil sector. That said, such investments are usually as minority partners in projects led by the state-owned Petróleos de Venezuela, SA or PDVSA. Italy’s ENI, Japan’s Mitsubishi, Spain’s Repsol, and Chevron have managed to land such contracts in the Orinoco Tar Belt.

However big the potential of the Orinoco Tar Belt might be, however, it’s nonetheless an enclave of this extractive industry, accounting for relatively few jobs and largely disconnected from much of the rest of Venezuela’s economy. For the vast majority of Venezuelans, the companies they work for, buy from and contract are simply bereft of significant investment from abroad.

And if this is a lost opportunity for international investors, in the long term, it will be an even bigger handicap to Venezuela’s existing businesses and those interested in ever doing business there. In sectors like construction, light manufacturing, retail and services, Venezuelan firms are now cut off from not just foreign investment, but also from the technology foreign investment brings, and the cutting edge management techniques that come with it. Little by little, Venezuela’s ability to host genuinely competitive, world-class firms is being eroded.

The U.S. firms that remain in Venezuela – mostly legacy multinationals that came decades ago – are locked in a constant struggle to repatriate their local currency profits. As the government’s approval is required to turn local profits into greenbacks and delays for approval often run years, a number of firms find themselves in the surreal position of being profitable in bolivars but not in U.S. dollars. Pressuring the Venezuelan authorities to expedite profit-repatriation is just as likely to lead to expropriation as it is to lead to dollar approvals. Under those circumstances, incumbent firms can hardly be faulted for refusing to invest anything beyond the absolute minimum needed to keep plant and equipment running.

In this upside down world of Chávez’s war on those who would invest in Venezuela’s future, the expropriated firms are not the only unlucky ones. It is telling, for instance, that Ohio-based Owens-Illinois’ stock actually rose slightly last October, following news that the Chávez government would expropriate the firm’s local operations. For some, the Venezuelan government’s vague, non-committal promise of fair compensation may be worth more than the chance to stay in a country that won’t let you take your earnings home.